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Rocking robins

In an article in the New York Times last month, Warren Buffett laid out his case for buying equities, and American equities in particular. His basic investment premise was to “be fearful when others are greedy and greedy when others are fearful”. As he pointed out, there have been few periods in recent history when markets have been more fearful.

Following the effective collapse of the Western banking system and its rescue by governments in Europe and the US, markets remain nervous, clutching at every piece of bad news to reinforce the gloom. And there is plenty of it about, from bad US manufacturing numbers to rising unemployment.

Investors should be wary of weak businesses, particularly those that need capital to survive in an environment where new loans are hard to come by. However, as Buffett points out, there are plenty of sound, well capitalised companies that should be around for many years, indeed, posting record profits in five or 10 years. Given the valuations of some of these quality companies, there is a compelling case for considering selective investments at very attractive prices.

Buffett, for example, has taken a stake in Goldman Sachs. There is no certainty he has made the right move but it has the potential to generate highly lucrative returns.

There is little doubt that right now looks like a very bad time to disinvest. The bear market is relatively long in the tooth but it is impossible to say when a market will bottom. That is why investors such as Buffett are often prepared to take the risk of being early.

“What is likely,” he said, “is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”

Equities look cheap for investors willing to bear a high level of short-term volatility for the sake of longer-term gain. Currently, the stated yield on the UK stockmarket is higher than that of 10-year gilts for the first time since the few days it happened in March 2003. When equity yields cross over with bond yields, this is usually considered a buying signal for shares.

There are caveats. First, dividends on many stocks, particularly banks, are expected to fall or cut altogether as firms seek to conserve cash. Nonetheless, where yields prevail in good, solid companies benefiting from the demise of weaker rivals, the attractiveness of these stocks is likely to increase.

Second, there is the possibility that the world will go into a deflationary situation such as that endured by the Japanese for the past 18 or so years. This is not my central view at the moment but one has to recognise the possibility, the investment implication being to buy government bonds.

Arguably, conditions for equity investment are improving. Interest rates have been cut globally and these actions demonstrate the authorities’ collective determination to minimise the extent of a global recession.

Intuitively, since the US was first into this recession, it is likely it will be the first out. It is possible that US interest rates could fall as low as zero and good quality assets that pay income will move to being priced at a premium. The US authorities will be looking for other ways, fiscal and monetary, to get the US consumer spending again, both with tax cuts and public spending.

Companies with intrinsic value and their own funding should be able to grow dividends despite the harsher economic environment. Identifying these companies and sectors is part of the skill of investing. It requires investors to look beyond the hype in good times and the despair in the bad to assess the true fundamentals of those businesses that should prosper over the long term.

Stuck in the shadows throughout most of the bull market, it seems that corporate bonds could at last step into the spotlight, with spreads on investment-grade corporate bonds now appearing more attractive than during the dotcom crash.

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22nd February 201912:00 pm

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